Sustainable Investment in Emerging Markets

The World’s Most Powerful? The Rise of China’s Policy Banks

China’s Policy Banks: How the China Development Bank and Export Import Bank are becoming lender of choice for emerging markets.

China is a major economic power by many quantitative measures, the world’s principal manufacturer, its foremost exporter and the fastest growing major economy. A consequence of this rise has been the State’s go global policy, in the early 1990s the government instructed state owned enterprises (SOEs) to look abroad to expand in search of securing natural resources to ensure the contining rapid growth of the manufacturing sector inside China and secondly to seek out new markets for Chinese goods and services.

This go-global strategy has been driven by SOEs who have been carrying out the natural resource extraction, infrastructure development and building programmes, which have come to characterise Chinese firm’s international expansion. Providing the finance for the SOEs and for the governments of developing countries has been the role of China Development Bank (CDB) and the Export Import (EXIM) Bank. These two institutions provide the majority of China’s overseas lending.

World’s Most Powerful?

Like all Chinese banks they are SOEs and in CDB’s case went from provincial obscurity and near ruin thanks to an overwhelming bad debt portfolio to global players in the space of a generation. The rapid rise of the CDB’s lending has meant that it has recently outstripped the World Bank’s lending to Latin America and Africa, challenging its position as the primary creditor to the developing world and according to Henry Sanderson’s – China’s Superbank (2013) a book that argues that CDB is the world’s most powerful bank, on the basis of its impact on the largest number of people, its financial strength and political influence.

CDB and EXIM lend in a number of ways, it can be directly to the government of a developing country, the most significant example of this was the CDB loan to Venezuela for USD 40 billion, the proceeds of the loan are then often tied to Chinese contractors. Alternatively CDB and EXIM will lend to a Chinese SOE or a joint venture with a local firm with the purpose of extracting raw materials, another scenario might be providing finance for an equity stake in a local venture.

The Guiding Hand of Beijing

The Chinese policy banks are guided by the strategic requirements of the Chinese State, in that they aim to secure natural resources and open up markets for Chinese companies, they also have to act commercially and lend at commercial rates and select projects which are viable and creditworthy. Deborah Brautigam author of The Dragon’s Gift of points out that the vast majority of Chinese finance is at commercial rates and just 3% is discounted or subsidised. (Aid with Chinese characteristics). Chinese lending by China Development Bank is often confused with “aid” because it is fulfilling a “developmental” role, that is to say, it provides public goods which would not be provided by the private sectors. This is in contrast to the World Bank which mixes commercial lending via the IFC and IBRD as well as concessional lending via the IDA.

Both the World Bank and Chinese policy banks are one of few providers of long term finance in developing countries and China’s expansion of its lending has given countries a choice when looking for funding, which often private companies are unwilling to provide.

World Bank Vs EXIM & CDB

In some instances the EXIM and China Development Bank provide competition to the World Bank. For example the Ghanaian parliament debated and eventually accepted a loan from the CDB which meant forgoing funds from the World Bank. A major incentive for Ghana and defining feature of Chinese lending in comparison to the World Bank is that they do not insist on changes to government policy in return for funding, so called conditionality.

A central plank of Chinese foreign policy is non-interference in sovereign country’s affairs and this extends to its policy banks. Although as China’s global power grows this outlook is becoming increasingly unrealistic as the country’s interests and investments in other countries grows the desire to protect them overwhelms its principles. Critics (such as Paul Collier – a development economist) contend that this lack of conditionality means China is making governance worse in Africa, as it bankrolls dictators and regimes with a record of poor governance and reduces their incentive to democratise. The main culprits of this kind of phenomena are deemed to be President Mugabe of Zimbabwe and Bashir of Sudan. It is also argued that African governance is broadly improving and these are cases are increasingly the exception.

There is an apparent correlation between undemocratic, corrupt regimes and heavy concentrations of Chinese lending, but this is at least partly because China often lent to countries largely ignored by the west such as Angola and Sudan which had poor governance and were usually considered too risky to invest in by western companies.

While Chinese policy banks do not ask for changes in government policy, the use of the loan is a different matter and is often tied to using Chinese companies, so for example a USD 1 billion loan to Ecuador required 20% be spent on Chinese goods and services, while reportedly the majority of Venezuelan borrowing from China, as per the contract, has to be used on Chinese goods and service, while also giving the CDB scope to denominate half the loan in Yuan. In comparison the World Bank would insist on open, transparent and untied procurement for any funding its disburses.

Crude for Credit

CDB often uses a so called “oil for loans” repayment scheme, which is a way of China obtaining collateral for the large sums it extends to often uncreditworthy countries. A country such as Ecuador, Venezuela or Angola would pledge a certain amount of oil per day, which would be then purchased at market prices by China. Therefore the seller does not run the risk of selling oil too cheaply, but at the same time guarantees China a regular supply. This approach of mixing strategic and commercial interests makes for an interesting comparison to the World Bank, with its aim of poverty reduction and concessional lending.

The now ex-President of the World Bank Robert Zoellick welcomed Chinese competition in development finance and given the lack of capital available to the developing world there is scope for all both sets of institutions provide complementary funding, giving developing countries more options in borrowing options. Clearly the developing world is large and diverse place and a closer examination of the direction of funding point to the fact that China and the World Bank are to a large extent funding different countries.

China in Latin America

China has provided USD 75 billion in commitments to Latin American countries since 2005, with the CDB providing 82% of these loans. While in Africa Chinese financing has been widely acknowledged to have exceeded the World Bank’s funding. China’s funding in Latin America is heavily concentrated in Venezuela, Argentina and Ecuador, precisely the countries which have been viewed as excessively socialist, populist and or otherwise investor unfriendly. The World Bank by way of contrast has lent to those viewed as pro-market such as Mexico, Colombia and Chile. The exception is Brazil, which has taken large amounts from the World Bank and Chinese Banks, a reflection of its balanced foreign policy and mixed economy (meaning significant state intervention and a mix of commodities, manufacturing and services).

Across Africa Chinese funding has been heavily concentrated in Angola, Sudan, Ghana and South Africa, this partly is recognition of the relative strength of their economies, South Africa attracts significant World Bank funding as befits Sub-Saharan Africa’s premier economy. However Sudan has been largely off the World Bank radar for some time, thanks to a regime headed by Omar Bashir who is wanted by the International Criminal Court and accused of links to terrorism by the US, as well as a nation beset by civil conflict, which has not ended with the division of what was formerly Africa’s biggest country. Other countries such as Ghana have attracted significant sums from the World Bank and Chinese sources.

China’s financial flows to these seemingly uncreditworthy, politically unreliable and conflict ridden regimes highlights its strategic aim of securing a supply of natural resources to fuel its manufacturing sector. The figures bear this out, in Latin America Chinese funding was channelled (87% ) primarily into energy, mining, infrastructure, transportation and housing projects (EMITH), while the World Bank focused on just 34% to the EMITH sector, preferring to focus more on health and environmental projects.

China’s Achilles Heel – The Environment

Chinese banks have been heavily criticized for their lack of respect for national and international environmental and social norms, perhaps a result of the poor environmental protections in China along with a lack of labour rights, both a cause and effect of the country’s industrial boom. These concerns led Paul Wolfowitz (another ex-President of the World Bank) to criticize the Chinese companies who “do not respect” Equator Principles that set social and environmental standards for lending.

In comparison projects involving the World Bank with an environmental impact would involve a lengthy round of consultations and engagements with government, NGOs and civil society actors. This environmental and social protection benchmark set by the World Bank and other western institutions has created a climate in which others are judged, therefore development and growth without taking into account the environmental and social cost is increasingly unacceptable. This is not to say that the World Bank system is perfect or ideal, but its recognition that projects must take into account negative externalities has created pressure to improve standards for Chinese banks and companies.

China has responded to criticism, firstly by pointing out that its companies must abide with local laws and regulations, rather than imposing its own, this is a fair argument, but when particular small and poor countries dependent on one commodity, such as Zambia with copper, are reliant on Chinese companies and finance to support the key plank in the economy, then clearly the temptation to ignore or sidestep laws in order to keep the investors happy becomes difficult to resist. The (now ex) President of Zambia, Zata, moved from anti-Chinese rhetoric in opposition to a more pragmatic pro-Chinese stance once in power.

In the 2012 FOCAC summit in Beijing – China outlined guidelines that its companies should abide by whilst operating abroad, this marks a significant step in the “socialisation” of Chinese actors to international norms, and an indication that the benchmark set by the World Bank has made an impact on the Chinese Banks.

Eclipsing The World Bank

Chinese policy banks have outstripped the World Bank in new lending across the developing world and while there is some overlap in their lending footprints, it is notably that they are funding different countries and those tend to be more likely to be dictatorial and/or known to favour state intervention. Chinese banks also offer an alternative funding model, which promises no intervention in government policy, but does tie the proceeds of the loan to Chinese goods and services. China’s SOEs poor record in maintaining environmental standards can partly be attributed to the lack of pressure from the policy banks, which stands in contrast to the World Bank, which does insist on the use of environmental standards.